Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 404

A year like few others, but what's next?

The one-year anniversary of the low point in the S&P 500 index during the pandemic was 23 March 2021, so we want to put the trailing one-year return of 77% into context as we look ahead.

This was a rare event

With the help of Bernstein Research, we calculated trailing 12-month returns for every month-end beginning in 1882. We then aggregated all the return streams into buckets, as shown below. So, how rare was this past year’s return? Extremely.

Exhibit 1: Only a handful like it

All five previous examples of 75% or greater 12-month trailing returns occurred during the Great Depression of the 1930s, another period of extraordinary government economic intervention.

What’s unique about the response to the coronavirus pandemic is the speed at which the US economy exited the recession once the US Federal Reserve put a floor under credit risk.

Markets may be short term, but they’re not dumb

Financial markets are a discounting machine. They tend to ignore seemingly material factors such as high unemployment while zeroing in on things that really matter, such as free cash flow generation.

For instance, in the quarters preceding Franklin D. Roosevelt’s New Deal, investors looked through intense economic pain and suffering in anticipation of an explosion of economic growth in 1934. What followed was a strong, but short-lived, business cycle. After the effects of the early-New Deal stimulus had worn off in 1937, worries about deficits resulted in spending cuts and the economy contracted again. Financial markets anticipated that too, as evidenced by the rollercoaster market returns throughout the 1930s.

Bringing it back to the present day, following the lows of last March, the beneficiaries of the initial phase of the rally were stay-at-home stocks such as streaming services and video conferencing providers.

However, as the weeks passed, investors began to look though the uncertainty surrounding the virus to what could be a massive snap-back in US economic growth in the second half of 2021. They switched their focus, shifting capital away from free-cash-flow compounders — companies that are typically more in control of their own destinies — and toward the stocks and credits most leveraged to the economic outlook: cyclicals.

The significant outperformance of companies with highly indebted balance sheets or lower-quality income statements is characteristic of the early phase of a market cycle. Regardless of quality, those companies that are most directly leveraged to a rebound in economic growth have historically become market darlings. That pattern played out during the previous two business cycles, after the collapse of the dot-com bubble and again in the wake of the global financial crisis.

I don’t discount what the market is signaling. It may be short term, but it’s not dumb. The combination of an exceedingly high US savings rate (thanks to pandemic-driven government transfer payments) and pent-up consumer demand (after more than a year of lockdowns) should lead to an enormous pop in economic growth.

Exhibit 2: US stimulus has ballooned savings

Cross-cycle compounders will replace cyclicals

Most investors focus on the near term. That will probably never change. Therefore, it comes as no surprise that the market’s ability to predict what will happen in the short term is strong but weakens over the medium and long term. That’s why our focus is always on the out years.

At some point, as they always do, financial markets will look through the coming eye-popping economic statistics. They will begin to discount what business fundamentals will look like without the tailwind of exceptionally accommodative fiscal and monetary policy.

And if history is any guide, we expect that as policy normalises, investors will pivot back to the type of cross-cycle earnings-compounders that make up many of our core holdings. These 'compounders' grow or 'compound' their earnings better than lesser companies across cycles as their revenues hold up in difficult conditions. They deliver strong cross-cycle earnings growth.

Cyclicals will have had their day, as they often do in the early phases of a market cycle, but we believe secular trends will win out in the long run, rewarding patient investors as the cycle matures.

 

(Editor's note: A stock is secular when company earnings remain relatively constant regardless of other trends. Examples are consumer staples or products that households consistently use. A cyclical stock's price is more affected by changes in the economy).

 

Robert M. Almeida is a Global Investment Strategist and Portfolio Manager at MFS Investment Management. This article is for general informational purposes only and should not be considered investment advice or a recommendation to invest in any security or to adopt any investment strategy. Comments, opinions and analysis are rendered as of the date given and may change without notice due to market conditions and other factors. This article is issued in Australia by MFS International Australia Pty Ltd (ABN 68 607 579 537, AFSL 485343), a sponsor of Firstlinks.

For more articles and papers from MFS, please click here.

Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries.

 

RELATED ARTICLES

A few big companies drive market results

Redefining risk for income investors

High or low price, future returns will be low

banner

Most viewed in recent weeks

Super changes, the Budget and 2021 versus 2022

Josh Frydenberg's third budget contained changes to superannuation and other rules but their effective date is expected to be 1 July 2022. Take care not to confuse them with changes due on 1 July 2021.

Noel's share winners and loser plus budget reality check

Among the share success stories is a poor personal experience as Telstra's service needs improving. Plus why the new budget announcements on downsizing and buying a home don't deserve the super hype.

Grantham interview on the coming day of reckoning

Jeremy Grantham has seen it all before, with bubbles every 15 years or so. The higher you go, the longer and greater the fall. You can have a high-priced asset or a high-yielding asset, but not both at the same time.

Whoyagonnacall? 10 unspoken risks buying off-the-plan

All new apartment buildings have defects, and inexperienced owners assume someone else will fix them. But developers and builders will not volunteer to spend time and money unless someone fights them. Part 1

Buffett says stock picking is too hard for most investors

Warren Buffett explained why he believes most investors should not pick stocks but simply own an S&P 500 index fund. "There's a lot more to picking stocks than figuring out what’s going to be a wonderful industry."

Should investors brace for uncomfortably high inflation?

The global recession came quickly and deeply but it has given way to a strong rebound. What are the lessons for investors, how should a portfolio change and what role will inflation play?

Latest Updates

Exchange traded products

ETFs are the Marvel of listed galaxies, even with star WAR

Until 2018, LICs and LITs dominated ETFs, much like the Star Wars franchise was the most lucrative in the world until Marvel came along. Now ETFs are double their rivals, just as Marvel conquered Star Wars.

Shares

Four leading tech stocks now look cheap

There are few opportunities to buy tech heavyweights at attractive prices. In Morningstar’s view, four global leaders are trading at decent discounts to their fair values, indicating potential for upside.

Shares

Why copper prices are at all-time highs

Known as Dr Copper for the uncanny way its price anticipates future economic activity, copper has hit all-time highs. What are the forces at play and strategies to benefit from the electric metal’s strength?

Economy

Baby bust: will infertility shape Australia's future?

In 1961, Australian women had 3.5 children on average but by 2018, this figure stood at just 1.7. Falling fertility creates a shift in demographics and the ratio of retirees to working-age people.

SMSF strategies

The Ultimate SMSF EOFY Checklist 2021

The end of FY2021 means rules and regulations to check for members of public super funds and SMSFs. Take advantage of opportunities but also avoid a knock on the door. Here are 25 items to check.

Economy

How long will the bad inflation news last?

The answer to whether the US inflation increase will prove temporary or permanent depends on the rates of growth of the quantity of money. It needs to be brought down to about 0.3% a month, and that's a problem.

Economy

The ‘cosmic’ forces leading the US to Modern Monetary Theory

If the world’s largest economy adopted a true MMT framework, the investment implications would be enormous. Economic growth would be materially greater but inflation and interest rates would also be much higher.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.